Market structure

Review: Market Structure
Prepared by César R. Sobrino
Universidad del Turabo
August 23, 2017
Prepared by César R. Sobrino Review: Market Structure

Outline
1 Perfect Competition
2 Imperfect Competition - Market Power
Selling-side
Monopoly
Oligopoly
Monopolistic Competition
Buying-side
Monopsony
Oligopsony
Monopsonistic Competition
3 Market Failures
4 Common Barriers to Entry

Perfect Competition
It is rare in the real world.
E.g. stock market and agricultural industries.
Many buyers (firms) and many identical individual
firms (workers).
Homogeneous or standardized products.
Firms are price takers. They cannot influence on price.
Individual firm faces a perfectly horizontal demand.
Free entry and exit.
Perfect information about characteristics of goods and
their prices. Knowledge is shared evenly between all
participants.

Perfect Competition- Benefits
Firms make normal profits to cover their opportunity
cost.
No costs for advertising.
Maximum economic welfare
Maximum consumer surplus.
Maximum producer surplus.
Maximum allocative and productive efficiency.
Market clearing
All goods that consumers desire to buy are bought at
the market price
All goods that producers desire to sell are sold at the
market price.
No externalities

Perfect Competition - Industry

Market Power
The less elastic the firm’s demand, the greater its
degree of market power.
When demand is perfectly elastic (demand is
horizontal), the firm has no market power.
The fewer close substitutes for a firm’s product, the
smaller the elasticity of demand (in absolute value)
and the greater the firm’s market power.

Monopoly
It exists when a single firm is the sole producer of a
product for which there are no close substitutes.
E.g. public utilities, professional sports leagues, etc..
The firm and industry are synonymous.
Many buyers.
The firm is the price maker (market power).
Entry or exit is blocked.

Monopoly

Monopoly: Price discrimination
Price discrimination is selling a good or service at
different prices
The price differences are not justified by the cost
differences.
In order to price discriminate, a monopoly must be
able to segregate the market and make sure that
buyers cannot resell the original product or services.
E.g. Airline fares, Museum fees, Gym fees,
Membership Clubs, Utilities, Membership-only
warehouse clubs, etc..

Oligopoly
Few large firms dominate a market.
E.g. automotive industry, brewery industry, banking
industry, etc..
Entry is hard.
Firms may produce either standardized or
differentiated products.
Each firm must consider its rivals’ reactions in response
to its decisions about prices, output, and advertising.
Strategic behavior
Actions taken by firms to plan for and react to
competition from rival firms
Game theory
Tool to analyze oligopolistic markets

Oligopoly
Interdependence: Decisions made by one seller
invariably aﬀect others and are invariably aﬀected by
others.
Competition: Rely on pricing, production, and
budget of advertising.
Mergers: Firms often pursue cooperation through
mergers–legally combining two separate sellers into a
single seller. Doing so gives the resulting buyer greater
market control.
Collusion: Two or more sellers that secretly agree to
control prices, purchasing, or other aspects of the
market. The suppliers behave as if they were one
supplier, as well. E.g Organization of the Petroleum
Exporting Countries (OPEC).

Monopolistic Competition
It refers to a market situation with a relatively large
number of small sellers offering similar but not
identical products.
E.g. fast food restaurants (food court), clothing stores,
gas stations, etc..
Many buyers and many sellers.
Differentiated products: variety of the product makes
this model different from pure competition model.
Advertising is needed.
Product differentiated in style, brand name, location,
advertisement, packaging, pricing strategies, etc.
Easy entry or exit.

Monopsony
The only buyer of a good in a given market, often an
input market
E.g. coal mine owner in town where coal mining is
primary source of employment, a dairy firm buying
milk production, government in employment of civil
servants, nurses, police, food retailer purchasing
supplies from farmers, wine growers and other
suppliers, Amazon’s buying power in the retail book
market, The National Health Service as a purchaser of
prescription drugs from the pharmaceutical firms, etc..
One consumer/firm and many sellers/workers.
Monopsony can reduce the quantity of an input
demanded in order to depress the price of that input.
Barriers to entry

Oligopsony
Few firms dominate the purchase of goods / services /
factors of production.
Those firms pay low prices for inputs.
E.g. the big supermarkets have market power in
buying supplies from farmers and milk producers,
media sub-sectors where a few companies publish
records, films and books, but there are many
musicians, actors, writers etc.
Few consumers/firms and many sellers/workers.
Barriers to entry.
Strategic behavior
Actions taken by firms to plan for and react to
competition from rival firms.
Game theory
Tool to analyze oligopsonistic markets.

Oligopsony
Interdependence: Decisions made by one buyer
invariably affect others and are invariably affected by
others.
Competition: Rely on pricing, waging, working
conditions, fringe benefits, and assorted non-wage
amenities.
Mergers: Firms often pursue cooperation through
mergers–legally combining two separate buyers into a
single buyer. Doing so gives the resulting buyer greater
market control.
Collusion: Two or more buyers that secretly agree to
control prices, purchasing, or other aspects of the
market. The buyers behave as if they were one buyer.

Monopsonistic Competition
Characterized by a large number of relatively small
competitors, each with a modest degree of market
control.
This is the buying side counterpart of monopolistic
competition on the selling side.
E.g. small textile ﬁrms hiring workers
Easy entry or exit.

Market failures
Social economic efficiency: Exists when the goods
and services that society desires are produced and
consumed with no waste from inefficiency.
Two necessary conditions: Productive efficiency and
Allocative efficiency.
Achieved by perfect competitive markets without
government regulation (private costs = social costs).
Market failure occurs when a market fails to achieve
social economic efficiency.
A divergence between social costs and private costs
brings a mismatch between production and
consumption (private costs ± external costs = social
costs)

Types of Market Failures
Natural Monopoly: When a single firm can produce
total consumer demand for a good or service at a lower
long-run total cost than if two or more firms produce
total industry output
Increasing number of firms drives up total cost and
undermines productive efficiency.

Natural Monopoly

Externalities: When actions taken by market
participants create either benefits or costs that spill
over to other members of society
Positive externalities occur when spillover effects are
beneficial to society (Silicon Valley).
Negative externalities occur when spillover effects are
costly to society (pollution).
Externalities undermine allocative efficiency

Common Property Resources:
Resources for which property rights are absent or
poorly deﬁned
No one can eﬀectively be excluded from such resources
Without government intervention, these resources are
generally overexploited and undersupplied

Public goods: A public good is nonexcludable and
nondepletable
The inability to exclude non-payers creates a
free-rider problem for the private provision of public
goods.
Even when private ﬁrms supply public goods, a
deadweight loss can be avoided only if the price of the
good is zero.

Information Problem: Market failure may also
occur because consumers lack perfect knowledge
Perfect knowledge includes knowledge about product
prices, qualities, and any hazards.
Market power can emerge because of imperfectly
informed consumers

Common Entry Barriers
Economies of scale (E.g. Brewery industry, soft
drink industry, aeronautical industry, automotive
industry, etc.)
Barriers created by government (E.g Licenses,
exclusive franchises)
Essential input barriers (one firm controls a crucial
input in the production process.
Brand loyalties: Strong customer allegiance to
existing firms.
Consumer lock-in: high switching costs will keep
potential entrants from inducing many consumers to
change brands.
Network externalities: when benefit of a product
increases as more consumers buy and use it.

Market structure

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